Ignore the scaremongers--Social Security `crisis' fixable

November 09, 2004|By Amity Shlaes, a syndicated columnist with the Financial Times.

Public pension liabilities are regarded as the single greatest domestic problem confronting developed nations.

Technically, fiscally, morally or politically, whatever way you look at it, pension reform seems close to impossible. Just recently in Japan, for example, lawmakers scuffled like hamsters on the Diet floor when the time came to vote on painful pension reductions for the elderly. And as Jacques Chirac, the president of France, is learning, voters do not exactly appreciate efforts to impose realistic changes. Even in the U.S., political groups on both left and right tend to deploy scary terms--"demographic disaster," for example--when they speak of public pensions. Small wonder that President Bush's blithe post-election announcement that he already had a "good blueprint" for reforming Social Security sounded like a boast.

It was not. For unlike European nations or Japan, the U.S. does not have a pension crisis. It has an enormous future shortfall that is eminently rectifiable. Collectivists find the crisis mode convenient because they want to use Social Security reform as an excuse for a more general redistribution of wealth. Free marketeers want a crisis because they think it might help them force through privatization of Franklin Roosevelt's grand program. But such political motives do not make the crisis a reality.

Indeed, there is not just one good blueprint for fixing Social Security--there are many. What's more, the best of these do not require raising tax rates for workers. This even though the U.S. public pension tax--12.4 percent shared by employer and employee--seems achingly low to outsiders.

The first such blueprint involves benefit formulas. Under the current system, retiree benefits are indexed to prices. But they are also linked to the average wage in America during the years that the retiree worked. And in the last half-century, the average national wage has increased 1 percent a year more than prices. All this means that a younger brother who follows the same career path as his big sister will get a larger pension than the sister, even after adjusting for inflation. This system, known as wage indexing, constitutes a social pledge perpetually to increase the standard of living for retirees down the generations. Such a promise might be hard to break if most Americans knew about it. But few have even heard of wage indexing.

Altering the system so that successive cohorts get the same amount after inflation should be possible. But here is the best bit: The simple step of ending wage indexing would wipe out nearly all of America's multitrillion-dollar unfunded pensions liability.

What's more, as economists point out, there is enough fiscal room to tinker a bit by allowing lower earners to continue on the wage indexing system as higher earners move into a price-index regime. That more expensive plan would still eliminate 71 percent of the unfunded liability. So much for inevitability.

Higher earners should be eager to accept this compromise, since it obviates future tax increases. What terrorizes them is the prospect of a Robin Hood fix that raises taxes progressively.

But there is of course another possible reform--privatization. Instead of paying all his 6-plus percent to the government, the worker might allocate some of those percentage points to stock or bond funds. Higher returns would in the end make it possible to reduce government payments. This plan doesn't need a "crisis" to be valid; it stands on its own.

But perhaps we should step back and ask what makes the U.S. pension dilemma so solvable. Demography is the most visible answer--the American workforce is a bit younger and so counts more workers per retiree. Also, there is the shareholder culture, which, although bruised, remains strong. Without action, however, this sunny moment will pass for good.

In pension terms, the U.S. is now where Japan was in 1991 and where Italy was in 1970. What those countries would not give to win back that time? No wonder Bush is acting boldly. When it comes to the painless reform blueprint, the rule is clear: Use it or lose it.